Saturday, March 7, 2009

Is the financial community double dipping the Bail Out money?

One of the central themes of the current financial crisis is the mismanagement of Credit Default Swaps (CDS). CDS policies were issued indiscriminately without setting aside adequate reserves to cover potential claims.

CDS’s are insurance contracts that enabled banks to acquire the assets, collateralized debt obligations or CDO’s, which now supposedly have all become toxic. A CDS was supposed to protect the banks against a default of a CDO. If a CDO went bad/toxic the issuer of CDS insurance would pay the bank the full value of the CDO.

AIG is the biggest issuer of these insurance policies (CDS) for which it had insufficient reserves to be able to cover if all the claims started pouring in.

Well, unfortunately the claims started pouring in due to the defaults of CDO’s (toxic assets) that these CDS policies covered.

To stop AIG from going bankrupt on account of its inability to pay all these claims, the government bailout so far has given them $300 billion of tax payers’ money with no end in sight.

This $300 billion is rapidly used to satisfy the claims that financial institutions, including banks have on these policies.

Unless of course the banks were so stupid not to insure their risky Collateralized Debt Obligations CDO’s by taking out CDS policies,these CDO’s are covered. So why are so many of these CDO’s toxic?

So if the now roughly $300 billion bailout of AIG is used to pay the claims on credit default swaps to the banks. And those same banks are being propped up by a trillion dollar government bailout package because initially the banks would not be able to collect the credit default swap claims from a bankrupt AIG when in fact they can because the government is paying AIG the money to do so.

Is someone here double dipping? Or is something more sinister going on, like the AIG money going somewhere else?